US CUURENT ACCOUNT DEFICITCASE STUDY SOLUTION

BY:

GROUP 3Section-1

ADITYA R. (DM16102)ANMOL CAUL (DM16109)ASTHA SINGH (DM16113)

HIMANSHU SHEKHAR (DM16118)KOLLI NAGA MOUNIKA (DM16122)SHWETA PRABHAKAR (DM16145)

US CURRENT ACCOUNT DEFICIT

U.S. has been a current account deficit country for long since 1989. It reached its peak

in 2011 and has subsequently fallen. The U.S. current account deficit fell by 3.8% to

$98.5 billion the 3rd quarter of 2014. As a percentage of gross domestic product

(GDP), the current-account deficit is 2.3%. Within the current account the US has a

deficit in goods but has a surplus in trade of services. Most of the capital inflows are

used to finance current public and private consumption rather than capital investments

to trigger exports, as US is already a developed economy. The following factors

contribute to the CAD

1) The US people have a propensity to consume more. This has naturally

increased the imports and the exports have not increased in the same way.

2) US exports are less desirable as they are dearer because of high labour

cost, and they face a stiff competition from Chinese exports. Hence

consumption of domestic goods has decreased.

3) Low savings of the country and increase in household debts.

4) Foreign ownership of US capital stock has been increasing, with china

being one of the largest holders of US bonds. Thus the profits earned out

of these investments go back to other foreign countries and doesn’t help in

reducing the CAD.

5) Increase in the value of $ has led to an increase in the amount of foreign

debt. The US is one of the world’s largest debtors.

Financing the current account deficit by borrowing is unsustainable in the long run.

But the US CAD can sustain as long as other currencies are pegged to USD. The US

can readily attract capital in the form of dollar securities to finance the deficit. As long

as this continues; US will enjoy the benefit of having a higher CAD. Devaluation of

the US dollar could reduce the widening of the current account deficit, but it is not a

long term solution and due to high investor confidence in the US market, this seems

unlikely.

The current account deficit has now dropped to a lowest level since 1997. The US

economy is moving towards a more stable BOP. This has been mainly driven by a

growth in domestic energy production and energy trade, along with service exports.

To make the U.S. current account and trade deficits sustainable, structural reforms are

needed in United States that encourages global growth, boost U.S. household saving

rates, and increase the markets for U.S. exports.

Some of the key measures needed are:

1) Raising house hold savings rate

2) Reducing trade barriers in service sector and opening up more markets.

3) Improving labour productivity, creating more skilled labour and reducing cost

of production so that volume of exports increases.

4) Global economy should also pickup leading to favourable scenario for US

exports. This needs more liberalisation.

Hence a shift in the policy which focusses more on investments in tradable goods and

services, and encourages savings is needed for sustainability.